Inflation Remains The Focus of The Analyst Community

Inflation Remains The Focus of The Analyst Community

March 13, 2024

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Last week I reiterated that I had an expectation that we would see some kind of a contraction or pullback in the equity markets in the near future, as it has been 19 weeks straight up in the S&P 500. As I had shown in the chart, this is longer than the previous two upward runs since the October 2022 lows. It was a run higher that has not only lasted longer but extended further. To refresh the illustration, here is the latest update taking into account last week's gains:

 

What I feel is most important to remember is that of proper perspective. For those with short term memories, or short-term exposure to the markets, the run for the year 2023 was a very nice one and the beginning of 2024 has seen a continuation of this move higher. But if we extend the time period from a daily graph to a weekly graph, it is seen that all the markets have done is come right back to the old highs that they saw in late 2021. In discussions with many investors, the subject of individual portfolios is often discussed. Quite often the phrase from long-term investors is, "Thank goodness I'm back to my old highs back in 2021." This was my point in my letter of last week when I said that a new market advance had just begun. The reason why it has just begun is that it has spent two years digesting the last move higher and now seems to be exhibiting the internal strength to move out to higher highs. To show these two periods is very important so that one understands the difference between the short-term and the longer-term. This allows perspective to be crystal clear!

Please note that at the right-hand side, there are three vertical blue lines. I input a stochastic oscillator to show the strength of the advance at different points (which has a red shading around it). Note that each of the three blue lines hits a successively lower high on the stochastic. I have stressed this by the declining arrow seen in the lower right. This tends to indicate a loss of momentum or strength of the advance. I mean this not to say that I believe that the advance is over, but rather there could be a pause to refresh. Below I then show the weekly chart that takes price levels back to the late 2021 time period. It can be seen that this high point seen above corresponds to the high point in the upper right seen below in the weekly.

Please note the horizontal red line that connects the high print of 2021 with the high print of last Friday. Clearly it is not a coincidence that the market happened to finally get a little tired, after 19 weeks of straight up, right at this point. Oftentimes previous high or low points tend to be points of indecision where markets are concerned to see if they either find bottoms at previous lows or find highs at previous highs.

Many times, other markets like interest rates, commodities, or foreign equity markets will be exhibiting changes at points like this. This could often mean a shift in large institutional asset pools to other investments. I look for other major markets exhibiting a change for somewhat of a confirmation of this point. In this case, gold has broken out in price, Bitcoin has broken out in price, and the 10-year US Treasury yield has broken below 4.2% and seems destined to move lower. On the front page of yesterday’s Wall Street Journal the center article was, “Big Gold Rally Surprises Wall Street.” This is what I am referring to! The Journal attributes this to global political unrest, but whatever the reason, this change is occurring at the same time as other changes are occurring.

Let me be clear though that caution is warranted. Despite the bullish case for the markets due to seasonal and presidential election cycles, the building blocks for a trend exhaustion have been building up. In addition to the bearish reversal last Friday, I would like to see a move lower in the overbought indicators or oscillators. At the same time, it would be best if the market keeps its longer-term uptrend. There are many analysts that banter different price levels on the index that they feel act as support, but I believe Thomas Lee of Fundstrat has said it best stating that he expects a 7-10% pullback before the indexes get back on their advance.

The real question that comes to mind when major indexes stumble is whether the market advance seen this year is as good as it gets? I don't believe so as a composite of investor surveys reached 87%, according to Ari Wald and this marks the most optimism in the indicator composite since 2018. Ari stated this past weekend, "Overall, high optimism has become a contrarian concern. However, we believe these near-term excesses can be relieved through high-level consolidation within an ongoing advance." He goes on to bring up the small and medium company indexes, which are coming off quite long bases and beginning to join the larger-cap S&P 500 index. Should these broader indexes begin to exhibit positive behavior this would be very healthy and prove that the "Magnificent Seven" are no longer the only companies that are acting well. 

It appears that the fuel needed for further market advances could be linked to the Fed finally loosening the purse strings. According to David Kelly, Chief Global Strategist at JP Morgan Asset Management, the argument for cutting rates, even if the economy is healthy, is twofold. One, if inflation comes down and the Fed doesn't cut rates, then real rates have gone up. Policy would get tighter, and the Fed doesn't want that to happen. Second, Fed Chair Jay Powell has made it clear that if the Fed's target is 2% inflation, they should be cutting rates before inflation hits 2% because monetary policy works with a lag. 

In the end, long-term investors are still and shouldn't be sitting on so much cash. They are not going to meet their financial goals sitting in short-term instruments. They should be building a portfolio that is diversified and able to take advantage of long-term trends rather than just hiding on the sidelines until everyone "feels better." Bank of America research said that there were record withdrawals from technology funds and ETFs last week. JP Morgan, Citibank, and Wedbush Securities were out Monday of this week commenting that they did not feel we were in a "bubble." They feel that large technology companies are underpinned by positive earnings and revenues. Real earnings in these behemoths are happening now. Also, car companies, drug companies, banks, etc. all are benefiting from the work of these AI based large-cap tech companies. Goldman Sachs pointed out that the catch up by the laggards is more likely than a catch down by the leaders. Citi went on to say that there appears to be no end in sight for GenAI. 

It is never fun when the sun has been shining and the weather all of a sudden turns cold and windy. The weather has been great in the markets for quite some time. Maybe a short-term change in the weather is due. We just don’t want a new winter to come too early. Springtime would be far more enticing.



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